Case 1 (Common-Size Statements and Financial Ratios for Creditors)

Requirement 1

This Year Last Year

a. Current assets ...........................................................................................................

P2,060,000 P1,470,000
Current liabilities .....................................................................................................
1,100,000 600,000
Working capital ........................................................................................................
P 960,000 P 870,000

b. Current assets (a) .....................................................................................................

P2,060,000 P1,470,000
Current liabilities (b)................................................................................................
P1,100,000 P600,000
Current ratio (a) ÷ (b) ..............................................................................................
1.87 to 1 2.45 to 1

c. Quick assets (a) ........................................................................................................

P740,000 P650,000
Current liabilities (b)................................................................................................
P1,100,000 P600,000
Acid-test ratio (a) ÷ (b) ............................................................................................
0.67 to 1 1.08 to 1

d. Sales on account (a) .................................................................................................

P7,000,000 P6,000,000
Average receivables (b) ...........................................................................................
P525,000 P375,000
Turnover of receivables (a) ÷ (b) .............................................................................
13.3 times 16.0 times

Average age of receivables:

365 ÷ turnover..........................................................................................................
27.4 days 22.8 days

e. Cost of goods sold (a) ..............................................................................................

P5,400,000 P4,800,000
Average inventory (b) ..............................................................................................
P1,050,000 P760,000
Inventory turnover (a) ÷ (b) .....................................................................................
5.1 times 6.3 times

Turnover in days: 365 ÷ turnover ............................................................................

71.6 days 57.9 days
f. Total liabilities (a) ....................................................................................................
P1,850,000 P1,350,000
Equity (b) .................................................................................................................
P2,150,000 P1,950,000
Debt-to-equity ratio (a) ÷ (b) ...................................................................................
0.86 to 1 0.69 to 1

g. Net income before interest and taxes (a) .................................................................

P630,000 P490,000
 Interest expense (b) ..................................................................................................
P90,000 P90,000
Times interest earned (a) ÷ (b) .................................................................................
7.0 times 5.4 times

Requirement 2

a. METRO BUILDING SUPPLY

Common-Size Balance Sheets

This Year Last Year

Current assets:
Cash ......................................................................................................................
2.3 % 6.1 %
Marketable securities............................................................................................
0.0 1.5
Accounts receivable, net.......................................................................................
16.3 12.1
Inventory ..............................................................................................................
32.5 24.2
Prepaid expenses ..................................................................................................
0.5 0.6
Total current assets ...................................................................................................
51.5 44.5
Plant and equipment, net ..........................................................................................
48.5 55.5
Total assets ...............................................................................................................
100.0 % 100.0 %

Liabilities:
Current liabilities ..................................................................................................
27.5 % 18.2 %
Bonds payable, 12% .............................................................................................
18.8 22.7
Total liabilities ..........................................................................................................
46.3 40.9

Equity:
Preference shares, P50 par, 8% ............................................................................
5.0 6.1
Ordinary shares, P10 par ......................................................................................
12.5 15.2
Retained earnings .................................................................................................
36.3 37.9
Total equity...............................................................................................................
53.8 59.1
Total liabilities and equity ........................................................................................
100.0 % 100.0 %

Note: Columns do not total down in all cases due to rounding.

b. METRO BUILDING SUPPLY

 Common-Size Income Statements

This Year Last Year

Sales .........................................................................................................................
100.0 % 100.0 %
Less cost of goods sold .............................................................................................
77.1 80.0
Gross margin ............................................................................................................
22.9 20.0
Less operating expenses ...........................................................................................
13.9 11.8
Net operating income ...............................................................................................
9.0 8.2
Less interest expense ................................................................................................
1.3 1.5
Net income before taxes ...........................................................................................
7.7 6.7
Less income taxes .....................................................................................................
3.1 2.7
Net income ...............................................................................................................
4.6 % 4.0 %

Requirement 3

The analysis of the requirements of (1) and (2), indicate the problems or the strengths that
exist in the Metro Building Supply:

The increase in the gross margin which is offset somewhat by an increase in the operating
expenses lead to the improvement of the company's profit margin from last year. In both
years the company’s net income as a percentage of sales equals or exceeds the industry
average of 4%.

The company’s working capital has also increased but both the current ratio and the
acid-test ratio are below the industry average, this is possibly happening, the financial
status or strength of a company cannot always be determined by just looking at the
working capital but also considering the other ratios. The decreased of the current and
acid test ratio, indicates that the company's current position is actually deteriorated since
last year, that soon it will impossible for the company to pay its bills as they come due.

This is also evident by both the common-size balance sheet and from the financial ratios.
The large buildup in accounts receivable and inventory is the reason why there's a drain
of cash. The company has a problem in collecting their accounts receivable and also their
inventory stocks are higher than on what they need. In the average age of receivables,
many of the customers are not taking their discounts, since the average collection period
is 27 days and collection terms are 2/10, n/30. This suggest sales to customers who are
poor credit standing or maybe the company has been too aggressive in expanding there
sales.
The inventory turned only 5 times this year as compared to over 6 times last year. It takes
three weeks longer for the company to turn its inventory than the average for the industry.

In our opinion, the loan should be approved on the condition that the company take
immediate and appropriate action to control the proper management of their accounts
receivable and inventory effective and efficiently. In accounts receivable, the company
must be strict in checking the credit standing of their customers before executing a sale.
While in inventory It would helpful if they use the economic order quantity in managing
their inventory to enable reduced of inventory levels to a more manageable size. If these
appropriate action or steps are taken, it appears that sufficient funds could be generated to
for the company to pay its bills as they come due on a reasonable time.

Case 2 (Financial Ratios for Ordinary Shareholders)

Requirement 1

a. This Year Last Year

Net income ...............................................................................................................

P324,000 P240,000
Less preference dividends ........................................................................................
16,000 16,000
Net income remaining for ordinary (a) ....................................................................
P308,000 P224,000
Average number of ordinary shares (b)....................................................................
50,000 50,000
Earnings per share (a) ÷ (b) .....................................................................................
P6.16 P4.48

b. Ordinary dividend per share (a)* .............................................................................

P2.16 P1.20
Market price per share (b) ........................................................................................
P45.00 P36.00
Dividend yield ratio (a) ÷ (b) ...................................................................................
4.8% 3.33%

*P108,000 ÷ 50,000 shares = P2.16;

P60,000 ÷ 50,000 shares = P1.20

c. Ordinary dividend per share (a)................................................................................

P2.16 P1.20
Earnings per share (b) ..............................................................................................
P6.16 P4.48
Dividend payout ratio (a) ÷ (b).................................................................................
35.1% 26.8%

d. Market price per share (a) ........................................................................................

P45.00 P36.00
Earnings per share (b) ..............................................................................................
P6.16 P4.48
Price-earnings ratio (a) ÷ (b) ....................................................................................
7.3 8.0
 Investors regarding Metro Building Supply is less favorably than other firms in the
industry. This is best described by the fact that they are willing to pay only 7.3 times
current earnings for a share of the company’s stock, as compared to 9 times current
earnings for the average of all stocks in the industry. It would be selling for about P55
per share (9 × P6.16), rather than for only P45 per share, if investors were willing to
pay 9 times current earnings for Metro Building Supply’s stock.

e. This Year Last Year

Equity .......................................................................................................................
P2,150,000 P1,950,000
Less preference shares .............................................................................................
200,000 200,000
Ordinary equity (a) ...................................................................................................
P1,950,000 P1,750,000

Number of ordinary shares (b) .................................................................................

50,000 50,000
Book value per share (a) ÷ (b) .................................................................................
P39.00 P35.00

Book value per share of ordinary shares measures the recoverable amount in the event
of liquidation if assets are realized at their book values. The difference of book value
and market value does not mean that the price of a stock is too high. Market value is
an indication of investors’ perceptions of future earnings and/or dividends, whereas
book value is a result of already completed transactions.

Requirement 2

a. This Year Last Year

Net income ...............................................................................................................

P 324,000 P 240,000
Add after-tax cost of interest paid:
[P90,000 × (1 – 0.40)] ..........................................................................................
54,000 54,000
 Total (a) ....................................................................................................................
P 378,000 P 294,000

Average total assets (b) ............................................................................................

P3,650,000 P3,000,000
Return on total assets (a) ÷ (b) .................................................................................
10.4% 9.8%

b. This Year Last Year

Net income ...............................................................................................................

P 324,000 P 240,000
Less preference dividends ........................................................................................
16,000 16,000
Net income remaining for ordinary
shareholders (a) ....................................................................................................
P 308,000 P 224,000

Average total equity* ...............................................................................................

P2,050,000 P1,868,000
Less average preference shares ................................................................................
200,000 200,000
Average ordinary equity (b) .....................................................................................
P1,850,000 P1,668,000

*1/2(P2,150,000 + P1,950,000); 1/2(P1,950,000 + P1,786,000).

Return on ordinary equity (a) ÷ (b) ..........................................................................

16.6% 13.4%

c. In both years, financial leverage is positive since the return on ordinary equity is
greater than the return on total assets. This positive financial leverage is due to three
factors, the preference shares, which has a dividend of 8%, also the bonds, which
have an after-tax interest cost of only 7.2% which is computed by [12% interest rate ×
(1 – 0.40) = 7.2%] and lastly the accounts payable, which may bear no interest cost.

Requirement 3
Based on our analytic work, we would recommend to retain the stock. The stock’s risk
seems so small, as we know that it is selling for only 7.3 times current earnings rather
than to 9 times earnings for the average firm in the industry. In addition, its earnings are
strong and trending upward, and its return on ordinary equity (16.6%) is extremely good.
Its return on total assets (10.4%) compares favorably with that of the industry.

The risk, of course, if they retain the stock is that is the company will may lead to a cash
problem under control. This may have a big impact or effect in the business. Specially
when problem in cash could worsen, leading to reduction in profits through inability to
operate, a reduction in dividends, and a deliberate drop in the market price of the
company’s stock. But if this does not happen, however, if the the company is able to
control its cash problem through more careful management of accounts receivable and
inventory. Which eventually when the problem is brought under control, the price of the
stock could rise sharply over the next few years, making it an excellent investment.